De-dollarization could be a slow puncture

Fahad Badar examines dollar dominance, reserve diversification and alternative payment systems, explaining why de-dollarization may be gradual.

The past month has seen extraordinary gyrations in geopolitics and the global economy. US President Donald Trump dramatically announced high tariffs on trading partners, then paused most of them in response to pressure on bond yields, and warnings from US retailers of empty shelves owing to a potential supply shock. 

There will likely be consequences for finance as well as trade, and there will be long-term effects even if tariffs are reversed soon or under a different President. 

For decades the US dollar has been the dominant reserve currency and the principal currency for international transactions. This has been described as an ‘exorbitant privilege’, allowing cheap borrowing and the ability of Washington to apply political pressure through financial sanctions. But President Trump’s team see it also as a problem, as it raises the purchasing power within the USA but makes exports more expensive, contributing to large trading deficits with some nations, notably China. 

There is therefore a case for targeted tariffs and devaluation. But the way in which he has gone about changing long-established policy, with threats of ultra-high tariffs, other negative consequences for nations that do not do his bidding, verbal attacks on erstwhile allies and frequent policy changes, has undermined confidence in US financial institutions. The value of the dollar has declined – it normally rises at times of uncertainty – and the gold price has risen. People are looking for alternatives.

The dollar remains pre-eminent. It accounts for 57% of official reserves, according to the latest figures by the IMF, and 49% of Swift international payments in 2024. This is far in excess of the share of the global GDP by the US economy, which is around 26%. 

The changes being brought about by the Trump administration are seismic. For years the US has used its exorbitant privilege to borrow cheaply and fuel growth, including huge rises in asset values. This has enriched many households, investors and businesses, but increased the inequality between those who own assets and those who do not. Both government and corporate borrowing levels are high, which is an inherent source of risk for the US economy.

Although President Trump wants to see a devaluation, he also wants to preserve the dollar’s pre-eminent status. He has threatened retaliation against those who do not continue to use the dollar as a reserve currency. These twin goals of devaluation and continued financial hegemony may be difficult to achieve, and there are signs that a policy of threats may be counter-productive. 

There is currently no single, compelling alternative to the dollar, but this does not mean that the situation will stay the same indefinitely. There could be a healthy rebalancing, with the euro and other alternatives increasingly in use as countries around the world lose confidence in US policy-making and institutions. So there could be a slow puncture in the dollar dominance rather than a sudden switch. 

President Trump seems to be overestimating the extent to which his threats compel other nations to yield to his will. They may seek alternatives to the dollar, and call his bluff should he double down on the threats. 

Two nascent developments are worth monitoring. They predate Trump’s second presidency but his policies could encourage further use. One is China’s Cross Border Interbank Trading System. Transactions which has 160 members and transaction volume has increased 80% since 2022. Another is mBridge, a digital currency linking the central banks of China, Hong Kong, the UAE, Saudi Arabia and Thailand. In addition, the euro is now mature as a large currency area, and around 22% of international transactions are denominated in euros, although this includes intra-EU transactions. The size of the EU economy is on a par with China.

The US will likely use inducements as well as threats, and sees a role for stablecoins to support dollarization. While there are more threats than encouragement coming from the White House, and unpredictable policy-making, trust in US institutions may continue to fall. President Trump could be pushing more trade, investment and reserve holdings away from the dollar, not in a sudden surge but through thousands of economic decisions over the years to come.

What we have learned in the past month is that global finance is collectively more powerful than the White House, and is moving in ways that the US President can influence but not control.